Like a poker player who's looking to win it all, MGM Resorts International (NYSE:MGM) is thinking about making a bold move. CEO Jim Murren says the company is considering restructuring its core operation into a real estate investment trust. That would have a significant impact on the company's business. Here's why MGM might want to make such a high-stakes move.
Sweet on REITs
Simply put, REITs are collections of real estate assets. They generally come in three flavors: mortgage, equity, and hybrid (a combination of the first two). MGM would package its property into an equity REIT that holds physical assets such as, well, casinos. These properties are typically rented to tenants; at their core, equity REITs are basically large-scale landlords.
REITs have two pronounced advantages over more traditional forms of corporation. First, much or all of their income is derived from rental agreements (in the case of equity REITs), producing revenue that tends to be relatively steady and predictable. This is attractive to many investors, and it helps REITs secure loans from creditors, who generally prefer cash flow they can count on -- casinos, after all, are expensive to build and thus difficult to finance.
Secondly, a REIT is required by law to pay out at least 90% of its profit to shareholders in the form of (typically high-yielding) dividends. The benefit to shareholders is obvious. Meanwhile, the REIT keeps its tax base very low, as it pays the IRS only on its retained income.
Companies that have turned REIT in the recent past have generally cleaved their business in two, dividing it into a property company and an operating company. With this technique, the property arm becomes a REIT that leases the real estate to the operating company. The latter remains a traditional corporation.
The opening bet
There's a precedent for REIT transformation in the gaming industry. In late 2013, Penn National (NASDAQ:PENN) effected this kind of split, with shareholders getting a prorated stake in a new REIT called Gaming and Leisure Properties (NASDAQ:GLPI), and the original company shifting into an operating company.
The REIT holds a clutch of casinos across the U.S., generally located in middle and small markets such as Columbus, Ohio and Joliet, Ill. The simplified REIT structure allows Gaming and Leisure Properties to post a high profit -- it raked in $44 million in Q4 2014 on net revenue of $159 million.
The REIT also saved a bundle on taxes, paying out less than $1 million for the quarter. Much of the cash that would otherwise go to Uncle Sam is flowing to investors; the company's dividend yields 6.1% at the current stock price.
Those kinds of numbers have a strong appeal in the gaming business. The board of Pinnacle Entertainment approved a REIT/operating-company split at the end of last year, and around the same time, Boyd Gaming admitted it was evaluating a similar possibility.
Time for a new hand?
MGM isn't habitually profitable: Its bottom line has landed in the black only once over the past five fiscal years. Those shortfalls have narrowed recently, however, and apparently the company's net operating loss carry-forwards (i.e., tax credits) are running low. If it's about to swing back into positive territory, and consistently so, it could save a pile on its future IRS bills if it restructures.
MGM also has a lot to gain by capitalizing on the theoretically lower costs of credit for REITs. At the end of its most recently reported quarter, the company carried nearly $13 billion of debt on its books. This was nearly the level of its property, plant, and equipment, and it was significantly higher than its cash and equivalents on hand ($2.3 billion).
The casino-to-REIT action is hot at the moment, and MGM could be getting ready to ante up for the game. That table has plenty of room for new players.